DIAKON AND CONTROLLED AFFILIATES. Consolidated Financial Statements and Schedules. December 31, 2017 and 2016

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1 Consolidated Financial Statements and Schedules (With Independent Auditor s Report Thereon)

2 Table of Contents Independent Auditor s Report 1 Consolidated Financial Statements: Consolidated Balance Sheets 3 Consolidated Statements of Operations and Changes in Net Assets 5 Consolidated Statements of Cash Flows Consolidating Information Schedule of Consolidating Information, Balance Sheet (Schedule 1) 44 Schedule of Consolidating Information, Statement of Operations and Changes in Net Assets (Deficit) (Schedule 2) 46 Schedule of Consolidating Information, Statement of Cash Flows (Schedule 3) 48 Page

3 actcpas.com 2599 Wilmington Road New Castle, PA fax Board of Directors Diakon and Controlled Affiliates Middletown, Pennsylvania Report on the Consolidated Financial Statements INDEPENDENT AUDITOR S REPORT We have audited the accompanying consolidated financial statements of Diakon and Controlled Affiliates, which comprise the consolidated balance sheets as of, and the related consolidated statements of operations and changes in net assets and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Diakon and Controlled Affiliates as of, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Bridgeport, WV Buckhannon, WV Charleston, WV Columbus, OH Meadville, PA Morgantown, WV New Castle, PA Pittsburgh, PA

4 Other Matter Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements as a whole. The consolidating information is presented for purposes of additional analysis rather than to present the financial position, results of operations and cash flows of the individual companies and is not a required part of the consolidated financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The consolidating information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the consolidated financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the consolidated financial statements as a whole. New Castle, Pennsylvania April 18, Arnett Carbis Toothman llp CPAs & Advisors

5 Consolidated Balance Sheets Assets Current assets: Cash and cash equivalents $ 4,520,783 4,043,657 Assets limited as to use 9,608,001 9,472,075 Accounts receivable (net of allowance for doubtful accounts of $3,041,000 and $3,098,000 in 2017 and 2016, respectively): Patients and residents 13,199,921 13,960,937 Statewide Adoption and Permanency Network 4,419,590 4,343,065 Other client services 2,565,094 2,938,956 Estimated third-party payor settlements 2,085,005 2,023,628 Prepaid expenses and other assets 2,452,991 3,831,416 Total current assets 38,851,385 40,613,734 Investments 133,066,932 58,005,785 Assets limited as to use, less current portion: Statutory minimum liquid reserves 7,122,163 7,205,935 Other 27,789,706 86,178,931 Investment in joint venture 958, ,409 Land, buildings and equipment, net 230,192, ,535,656 Other assets: Receivables from charitable gift annuities 1,233,426 1,233,426 Funds held in trust by others and beneficial interest in trust 37,685,817 34,556,795 Other assets 4,773,238 5,191,850 Total assets $ 481,673, ,118,521 3 (Continued)

6 Consolidated Balance Sheets Liabilities and Net Assets Current liabilities: Line of credit $ 1,529, ,238 Accounts payable and accrued expenses 19,392,465 20,654,712 Deposits patients and residents 661, ,281 Estimated third-party payor settlements 1,016, ,609 Current maturities of long-term debt 6,668,715 6,632,277 Total current liabilities 29,268,955 29,893,117 Pension liability 34,582,892 33,650,712 Deferred revenue entrance agreements 64,785,819 62,515,189 Refundable entrance fee liability 33,223,116 33,938,813 Other long-term liabilities 1,380,915 2,383,733 Long-term debt, less current maturities and debt issuance costs 240,315, ,291,528 Total liabilities 403,556, ,673,092 Net assets: Unrestricted 15,175,566 (10,569,367) Temporarily restricted 14,155,465 12,632,857 Permanently restricted 48,785,957 50,381,939 Total net assets 78,116,988 52,445,429 Total liabilities and net assets $ 481,673, ,118,521 See accompanying notes to consolidated financial statements. 4

7 Consolidated Statements of Operations and Changes in Net Assets Years ended Operating revenues, gains and other support: Patient and resident service revenue, net of contractual allowances $ 142,818, ,393,245 Patient and resident service revenue, nursing home assessment 3,868,169 3,866,533 Amortization of entrance fees 9,935,291 11,104,452 Contract revenue 12,202,254 10,824,383 Other fees and services 11,207,774 12,174,687 Statewide Adoption and Permanency Network revenue 62,008,007 57,918,104 Investment income, net of expenses 7,315,778 5,240,982 Income from trusts 1,617,440 1,501,690 Contributions and bequests 824,986 2,941,467 Net assets released from restrictions operations 1,638,403 1,451,531 Gain on disposal of assets 3,502,725 20,476 Total operating revenues, gains and other support 256,939, ,437,550 Expenses: Salaries and wages 67,728,628 66,829,858 Employee benefits 13,533,697 14,369,071 Other expenses 75,535,431 73,569,367 Other expenses Statewide Adoption and Permanency Network 60,338,942 57,013,588 Nursing home assessment 2,060,071 2,029,793 Interest 9,815,765 10,540,290 Depreciation and amortization 17,778,621 17,637,904 Total expenses 246,791, ,989,871 Operating income 10,147,848 6,447,679 Decrease in fair value of swap agreement (969,810) Equity in gains of joint venture 362, ,502 Loss from early extinguishment of debt (420,807) Excess of operating revenues, gains and other support over expenses 10,509,976 5,472,564 Other changes: Pension-related changes other than net periodic pension costs (971,950) (52,497) Unrealized gains on investments 8,910,261 1,087,336 Net assets released from restrictions capital 9, ,277 Equity transfer 7,287,574 Total other changes 15,234,957 1,139,116 Increase in unrestricted net assets 25,744,933 6,611,680 5 (Continued)

8 Consolidated Statements of Operations and Changes in Net Assets Years ended Temporarily restricted net assets: Contributions and bequests $ 624,674 1,193,911 Investment gains, net of expenses 2,165,874 1,517,035 Unrealized gains on investments 2,704,800 83,071 Net assets released from restrictions operations (1,638,403) (1,451,531) Net assets released from restrictions capital (9,072) (104,277) Change in beneficial interest in trust 186,209 Equity transfer (2,511,474) Increase in temporarily restricted net assets 1,522,608 1,238,209 Permanently restricted net assets: Contributions and bequests 237, ,353 Increase in fair value of funds held in trust by others 2,942, ,086 Equity transfer (4,776,100) (Decrease) increase in permanently restricted net assets (1,595,982) 842,439 Increase in net assets 25,671,559 8,692,328 Net assets, beginning of year 52,445,429 43,753,101 Net assets, end of year $ 78,116,988 52,445,429 See accompanying notes to consolidated financial statements. 6

9 Consolidated Statements of Cash Flows Years ended Cash flows from operating activities: Increase in net assets $ 25,671,559 8,692,328 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Net realized gains on investments (2,726,884) (1,121,597) Net unrealized gains on investments (11,615,061) (1,170,407) Depreciation and amortization 17,778,621 17,637,904 Amortization of debt issuance costs 169, ,341 Increase (decrease) in pension liability 932,180 (76,780) Amortization of entrance fees (9,935,291) (11,104,452) Proceeds from entrance fees 14,017,103 15,936,674 Change in funds held in trust by others and beneficial interest in trust (3,129,022) (354,086) Decrease in fair value of swap agreement 969,810 Equity in gains of joint venture (362,128) (415,502) Loss on early extinguishment of debt 420,807 Gain on disposal of assets (3,502,725) (20,476) Provision for bad debts 2,426,987 2,043,177 Restricted contributions and investment income (1,389,450) (1,747,768) Change in assets and liabilities: Accounts receivable (1,407,190) 17,878,157 Prepaid expenses and other current assets 1,378,425 (1,918,365) Other assets 418,612 Accounts payable, accrued expenses, and other liabilities (3,074,716) (15,363,421) Deposits patients and residents 36,682 (23,825) Net cash provided by operating activities 25,687,616 30,437,519 Cash flows from investing activities: Purchase of investments and assets limited as to use (26,726,029) (30,160,547) Proceeds from sales of investments and assets limited as to use 24,343,898 18,229,024 Purchase of property and equipment (21,323,167) (13,277,776) Proceeds from sale of property and equipment 6,200,000 Net cash used in investing activities (17,505,298) (25,209,299) Cash flows from financing activities: Payment of long-term debt (10,868,924) (34,748,122) Retirement of swap agreement (9,748,000) Proceeds from debt issuance 3,842,181 42,223,300 Net proceeds (payment) on lines of credit 542,144 (1,736,632) Payment of debt issuance costs (83,164) (895,183) Proceeds from restricted contributions and investment income 1,389,450 1,747,768 Proceeds from entrance fees 2,937,275 2,182,094 Refunds of entrance fees (5,464,154) (5,198,363) Net cash used in financing activities (7,705,192) (6,173,138) Net increase (decrease) in cash and cash equivalents 477,126 (944,918) Cash and cash equivalents, beginning of year 4,043,657 4,988,575 Cash and cash equivalents, end of year $ 4,520,783 4,043,657 Supplemental schedule of noncash investing activity: Noncash purchases of property and equipment $ 810, ,000 See accompanying notes to consolidated financial statements. 7

10 (1) Summary of Significant Accounting Policies (a) Organization Diakon is a private, nonprofit charitable organization recognized by the Internal Revenue Service as a 501(c)(3) corporation and exempt from federal income taxation under the group exemption of the Evangelical Lutheran Church in America (ELCA). Diakon is the sole member of Diakon Lutheran Social Ministries (DLSM), Diakon Lutheran Fund (DLF), Diakon Lutheran Senior Living-Maryland LLC (DLSL-MD), Diakon Child, Family and Community Ministries (DCFCM), Diakon Medical Group LLC (DMG), and Diakon Home Care Services LLC (DHCS). DLSM is the sole member of Diakon-SWAN LLC (SWAN LLC) and is related to four U.S. Department of Housing and Urban Development (HUD) senior housing projects by appointment of the boards of Diakon Lutheran Senior Housing at Heilman House and Diakon Lutheran Senior Housing at Luther Meadows, and by acting as sole member of Diakon Lutherwood Senior Housing LLC and Diakon Frostburg Senior Housing, LLC (DFSH), a sole purpose entity formed in 2016 which assumed the assets and liabilities of the Frostburg Heights project, which previously operated as a division of DLSM. DCFCM is the sole member of Old Main LLC (Old Main). Diakon is affiliated with ELCA through Lutheran Services in America (LSA), the membership alliance of Lutheran social ministry organizations and church bodies. Diakon has a relationship with the following participating synods: Delaware-Maryland, Lower Susquehanna, Northeastern Pennsylvania, Southeastern Pennsylvania, and Upper Susquehanna. Through a cooperative agreement, it also serves in the Allegheny Synod (collectively, the Synods). In accordance with Diakon s bylaws, the bishops of the Synods elect the majority of Diakon s board of directors. The bishops of the Synods also elect the majority of DLSM s and DCFCM s board of directors. The board of Diakon, in its role as sole member, appoints the board for DLF. (b) Description of Controlled Affiliates DLSM is a Pennsylvania nonprofit corporation recognized as a charitable organization under Section 501(c)(3) of the Internal Revenue Code and exempt from federal income taxation under the group exemption of the ELCA. DLSM provides senior living and health services in Pennsylvania. DLSL-MD, a Maryland Limited Liability Company, began operations on January 1, 2012, and is the operating entity for the retirement living community in Maryland. DLSL-MD is a disregarded entity of Diakon for federal tax purposes. DCFCM, a 501(c)(3) corporation, began operations on July 1, 2014, and operates various programs serving children, communities, and families. DHCS, a Pennsylvania Limited Liability Company, was previously the operating entity for home and community based hospice and home care services in Pennsylvania. Operations were discontinued in July DHCS is a disregarded entity of Diakon for federal tax purposes. 8 (Continued)

11 DLF, a 501(c)(3) corporation, is authorized by its charter to provide management of DLSM s and DCFCM s investments and solicit contributions for the charitable organizations that it supports. In the absence of donor restrictions, DLF has discretionary control over the amounts, timing, and use of its distributions to the charitable organizations that it supports. Certain of its funds are restricted to children, youth, community, and family programs. SWAN LLC, a Pennsylvania Limited Liability Company, began operations on October 1, 2015, and provides an array of administrative and support services for the Pennsylvania Statewide Adoption and Permanency Network, a program overseen and funded by the Pennsylvania Department of Human Services. SWAN LLC is a disregarded entity of DLSM for federal tax purposes. DMG, a Pennsylvania Limited Liability Company, began operations on January 1, DMG provides medical director and physician services to the Diakon senior living communities. DMG is a disregarded entity of Diakon for federal tax purposes. Old Main, a Pennsylvania Limited Liability Company, was created in 2017 to be the borrower and operator of the Old Main Building project at the Lutheran Home at Topton campus. Old Main is a disregarded entity of DCFCM for federal tax purposes. (c) (d) Basis of Consolidation The accompanying consolidated financial statements have been prepared to focus on Diakon and all controlled affiliated organizations (collectively, the Corporation) as a whole. All material intercompany transactions have been eliminated in consolidation. Basis of Accounting The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles and present balances and transactions according to the existence or absence of donor-imposed restrictions. Revenues are reported as increases in unrestricted net assets unless use of the related assets is limited by donor-imposed restrictions. Expenses are reported as decreases in unrestricted net assets. Gains and losses on investments and other assets or liabilities are reported as increases or decreases in unrestricted net assets unless their use is restricted by explicit donor stipulation or by law. Expirations of temporary restrictions on net assets (i.e., the donor-stipulated purpose has been fulfilled and/or the stipulated time period has lapsed) are reported as net assets released from restrictions on the consolidated statements of operations and changes in net assets. There are three classes of net assets permanently restricted, temporarily restricted, and unrestricted. Permanently restricted net assets are net assets subject to donor-imposed stipulations that are required to be maintained permanently by the Corporation. Generally, the donors of these assets permit the institution to use all or part of the income earned on related investments for general or specific purposes. Permanently restricted net assets consist principally of funds held in trust by others. 9 (Continued)

12 Temporarily restricted net assets are net assets subject to donor-imposed stipulations that may or will be met by actions of the Corporation and/or the passage of time. Unrestricted net assets are net assets not subject to donor-imposed stipulations. (e) Cash and Cash Equivalents Cash and cash equivalents include interest-bearing instruments with an original maturity of three months or less from the date of purchase, excluding amounts classified as assets limited as to use. The Corporation has exposure to credit risk related to cash on deposit at financial institutions in excess of FDIC insured limits. As of December 31, 2017, the amount held in excess of the FDIC insured limits at financial institutions was approximately $4,435,000. (f) (g) Accounts Receivable Accounts receivable from patients, residents, and clients are reduced by an allowance for doubtful accounts. In evaluating the collectability of accounts receivable, the Corporation analyzes its past history and identifies trends for each of its major payor sources of revenue to estimate the appropriate allowance for doubtful accounts and provision for bad debts. Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the allowance for doubtful accounts. Additionally, for receivables associated with self-pay patients the Corporation routinely reviews the provision for bad debts for delinquent accounts and adjusts reserves as appropriate for such accounts where there is a reasonable likelihood the resident is unable or unwilling to pay the portion of their bill for which they are financially responsible. The difference between the standard rates (or the discounted rates if negotiated) and the amounts actually collected after all reasonable collection efforts have been exhausted is charged off against the allowance for doubtful accounts. Investments and Investment Income Investments are measured at fair value on the consolidated balance sheets. Certain investments and assets limited as to use are maintained in investment pools (pooled funds). To equitably allocate investment income, including gains and losses, each participating fund is assigned a number of units using the market value method. Investment income and gains and losses on the sale of investments are added to or deducted from the appropriate net asset classification depending on the existence of donor-imposed restrictions. A decline in market value of any investment below its cost basis that is deemed to be other-than-temporary results in a reduction in carrying amount to the fair value. The impairment is recognized as a loss and a new cost basis for the investment is established. No such losses were recognized in 2017 or (Continued)

13 (h) (i) Assets Limited as to Use Assets limited as to use include assets set aside by the board of directors for future capital improvements and other designated purposes, over which the board retains control and may, at its discretion, use for other purposes; assets held by trustees under mortgage agreements with agencies of the U.S. government; assets held by trustees under bond indentures; and donor and other restricted funds. Investment income and gains and losses on assets limited as to use are included in investment income. Investment in Joint Venture Investment in joint venture represents an investment in a less than 50% owned information technology joint venture. The Corporation accounts for the equity interest it has in a for-profit joint venture where it has significant influence under the equity method of accounting. Changes in the venture s equity have been reflected on the consolidated statements of operations and changes in net assets as equity in gains (losses) of joint venture and classified consistent with the characteristics of the joint venture s activities. In December 2016 the joint venture entered into an agreement with the Corporation to convert additional paid in capital of $350,000 to debt in the form of a note receivable to be paid over ten years. As of December 31, 2016, the note receivable is included in other assets on the consolidated balance sheet. The note receivable was paid in full in December (j) Land, Buildings, and Equipment Land, buildings, and equipment are recorded at cost. The cost of maintenance and repairs is expensed as incurred, whereas significant renewals and betterments are capitalized. Depreciation is calculated on the straight-line method over the estimated useful lives of the depreciable assets. Depreciable lives are determined as follows: Land improvements Buildings Furniture and equipment Vehicles Leasehold improvements 10 to 25 years 10 to 40 years 3 to 20 years 4 to 7 years Lesser of lease term or life of the asset Gifts of long-lived assets such as land, buildings, or equipment are reported as unrestricted support unless explicit donor stipulations specify how the donated assets must be used. Gifts of long-lived assets with explicit restrictions that specify how the assets are to be used and gifts of cash or other assets that must be used to acquire long-lived assets are reported as restricted support. Absent explicit donor stipulations about how long those long-lived assets must be maintained, expirations of donor restrictions are reported when the donated or acquired long-lived assets are placed in service. 11 (Continued)

14 Interest cost incurred on borrowed funds less interest income earned on these funds during the period of construction of capital assets is capitalized as a component of the cost of acquiring those assets. (k) Impairment of Long-Lived Assets Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented on the consolidated balance sheets and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposal group classified as held-for-sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheets. No impairment was recognized in 2017 or (l) Deferred Debt Issuance Costs and Other Assets Debt issuance costs are amortized over the period the obligation is outstanding. Amortization expense was $169,914 and $175,341 in 2017 and 2016, respectively. Debt issuance costs incurred and subject to amortization totaled approximately $4,600,000 and $4,500,000 as of December 31, 2017 and 2016, respectively. Accumulated amortization as of, totaled $933,233 and $763,319, respectively. Other noncurrent assets include goodwill of approximately $4,600,000 related to the acquisition of a continuing care retirement community within the senior living services line of service. Goodwill is analyzed at least annually by management to assess whether it is more likely than not that the senior living services reporting unit goodwill is impaired based upon qualitative factors. The Corporation did not recognize an impairment loss on goodwill for the years ended December 31, 2017 or (m) (n) Receivables from Charitable Gift Annuities Independent trustees maintain charitable gift annuities for which the Corporation has been named beneficiary of the corpus and will receive these funds upon the death of the annuitant. Funds Held in Trust by Others and Beneficial Interest in Trust DLSM, or its predecessor entities, and DLF (the beneficiaries) have been named as the beneficiaries of a number of trusts that are administered and controlled by independent trustees. The trusts are recorded as contribution revenue when the beneficiaries are notified of the trust s existence. The beneficiaries receive the earnings from these trusts whose principal is to be held in perpetuity. The earnings from the trusts are recorded as investment income. 12 (Continued)

15 Funds held in trust by others and the beneficial interest in trust are valued at the fair value of the underlying investments. The change in the fair value of funds held in trust by others is reported as a change in permanently restricted net assets and the change in the fair value of the beneficial interest in trust is reported as a change in temporarily restricted net assets. Lifecare residents at one community requiring financial assistance have been named as the beneficiaries of a trust administered and controlled by independent trustees. (o) (p) Self Insurance Accounts payable and accrued expenses and other long-term liabilities include a provision for estimated self-insured workers compensation and health insurance claims for both reported claims not yet paid and claims incurred but not reported. Deposits Patients and Residents Deposits patients and residents represents security deposits paid in advance to cover possible costs when patients and residents vacate their apartments or personal care units. These deposits are taken into income only if earned upon the termination of a residency agreement. Deposits patients and residents also includes nursing home patients funds held in safekeeping by the Corporation for the patients personal use. (q) Pension Benefits The Corporation has a noncontributory defined benefit pension plan covering certain employees upon their retirement. The benefits are based on years of service and the employee s compensation. On August 17, 2011, DLSM (the plan sponsor) amended the pension plan to freeze benefit accruals, effective December 31, 2011, and to freeze participation with respect to new participants, effective January 2, The Corporation records annual amounts relating to its pension plan based on calculations that incorporate various actuarial and other assumptions, including discount rates, mortality, assumed rates of return, compensation increases, and turnover rates. The Corporation reviews its assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends when it is appropriate to do so. The effect of modifications to those assumptions is recorded as an other change in unrestricted net assets on the consolidated statements of operations and changes in net assets. These amounts are amortized to net periodic cost over future periods using the corridor method. The Corporation believes that the assumptions utilized in recording its obligations under its plan are reasonable based on its experience and market conditions. The net periodic costs are recognized as employees render the services necessary to earn the pension benefits. The funded status of the plan is reported in the pension liability caption on the consolidated balance sheets. The Corporation is required to recognize the funded status of defined benefit pension and other postretirement plans as a net asset or liability and to recognize changes in that funded status in the year in which the changes occur through other changes in unrestricted net assets on the consolidated statements of operations and changes in net assets to the extent those changes are not included in the net periodic cost. 13 (Continued)

16 (r) (s) Derivative Instruments The Corporation entered into an interest rate swap agreement to limit its exposure to interest rate changes on its variable rate revenue bonds. Hedge accounting has not been elected; therefore, variations in fair value are marked-to-market and reported within its performance indicator on the consolidated statements of operations and changes in net assets. In June 2016, the Corporation terminated the swap agreement (Note 8). Entrance Agreement Contracts Entrance fees paid by residents of the Corporation s independent living units, including certain cottages and apartments, are recorded as deferred revenue. A resident, upon termination of occupancy, is entitled to receive a refund of a portion of the entrance fee pursuant to the terms of the contract, which is required to be paid only upon the subsequent receipt of an entrance fee from a new resident for that independent living unit. These entrance fee agreements guarantee occupancy rights to residents for life. In certain contracts related to two of the Corporation s facilities, there are lifetime health care services. The nonrefundable portion of entrance fees as stated in each contract is recorded as deferred revenue and amortized to revenue over the estimated life expectancy of each resident. The component of entrance fees which is guaranteed refundable per the terms of a contract is recorded as refundable entrance fee liability. A refund payment can be triggered on the portion of a contract that is non-refundable, as the contracts contain provisions whereby the nonrefundable portion of the entrance fee is earned by the respective community over a future time period following the date of initial occupancy, generally 46 months or less. Nonetheless, all nonrefundable portions of the entrance fee are recorded as deferred revenue and amortized to revenue over the estimated life of the resident. Such entrance fees are amortized to income, as the Corporation does not have a reasonably objective basis to identify in advance which contracts are likely to trigger refunds. The amount of entrance fees, which is refundable to residents as of, under contractual refund provisions, was approximately $56,140,000 and $58,116,000, respectively. Proceeds and refunds of refundable entrance fees are classified as financing activities on the consolidated statements of cash flows. The Corporation may receive entrance fee payments prior to the date an independent living resident occupies a living unit. Such entrance fee deposits received during 2017 and 2016 amounted to $680,535 and $650,795, respectively, and are included in refundable entrance fee liability on the accompanying consolidated balance sheets. The Corporation maintains a separate entrance fee escrow account, which is a component of cash and cash equivalents. The amount in the entrance fee escrow account covers deposit liabilities to prospective independent living residents. Such amounts in the entrance fee escrow account totaled $843,392 and $751,416 as of December 31, 2017 and 2016, respectively. 14 (Continued)

17 (t) (u) (v) Conditional Asset Retirements The Corporation has evaluated its facilities to determine if it has a liability for the fair value of a conditional asset retirement obligation. The types of asset retirement obligations evaluated are those for which an entity has a legal obligation to perform an asset retirement activity; however, the timing and (or) method of settling the obligation is conditional on a future event that may or may not be within the control of the Corporation. No material conditional asset retirement obligations have been identified by the Corporation as of December 31, 2017 or Obligation to Provide Future Services to Continuing Care Residents The Corporation annually calculates the present value of the net cost of future services using a discount rate of 5% and compares that amount with the balance of deferred revenue from entrance fees. If the present value of the net cost of future services and the use of facilities exceeds the deferred revenue from entrance fees, a liability would be recorded (obligation to provide future services and use of facilities) with the corresponding charge to income. Periodically, the Corporation engages an actuary to perform the present value calculation, which it did in As a result of the calculation, and additional analysis performed in 2017, the present value of the net cost of future services did not exceed deferred revenue; accordingly, no obligation was recorded as of December 31, 2017 or Income Taxes Diakon and its controlled affiliates are not-for-profit corporations as described in Section 501(c)(3) of the Internal Revenue Code (Code) and have been recognized as tax exempt under 501(a) of the Code. The Corporation uses a threshold of more likely than not for recognition and derecognition of tax positions taken or expected to be taken in a tax return. The Corporation does not believe that there are any unrecognized tax benefits or liabilities that should be recorded. Generally, tax returns for years ended December 31, 2014, and thereafter remain subject to examination by federal and state taxing authorities. (w) Patient and Resident Service Revenue Patient and resident service revenue is reported at the estimated net realizable amount to be received from patients, residents, and others including Medicare, Medicaid, and other third-party payors for services rendered. Skilled nursing facilities derive a significant portion of their revenues from federal and state reimbursement programs. These reimbursements are subject to audit and periodic adjustment. Services provided to Medicare beneficiaries are paid under terms of a prospective payment system at predetermined rates based on clinical, diagnostic, and other factors. Services provided to Medicaid beneficiaries are paid at prospectively determined rates per day. 15 (Continued)

18 These rates vary according to a resident classification system that is based on clinical diagnostic and other factors, and the reimbursement methodology is subject to various limitations and adjustments. The Corporation s current concentration of skilled nursing facilities in Pennsylvania exposes it to the risk of changes in Medicaid reimbursement in this state. (x) Contributions and Donor Restrictions Contributions received with donor-imposed restrictions that are met in the same year as received are reported as increases in temporarily restricted net assets, and reclassified to unrestricted net assets as net assets released from restrictions. Contributions, including unconditional promises to give, if any, are recognized as revenues in the period received. Conditional promises to give are not recognized until they become unconditional, that is when the conditions on which they depend are substantially met. Contributions of assets other than cash are recorded at their estimated fair value as of the date of contribution. Contributions to be received after one year are discounted at an appropriate discount rate commensurate with the risks involved. An allowance for uncollectable contributions receivable is provided based upon management s judgment including such factors as prior collection history, type of contributions, and nature of fund-raising activity. (y) Charity Care and Support of Those in Need The Corporation provides charity care and other support of those in need to many of the programs and individuals that it serves. In addition, DLF provides support of children, youth, and family programs. Support of those in need includes services provided to persons who cannot afford health care because of inadequate resources and/or who are uninsured or underinsured. A number of programs operated by DCFCM do not receive sufficient funding from the sponsoring organizations or from program fees to meet the needs of the people they serve. The Corporation has elected to underwrite the operating deficits of certain programs in order to serve as many of the identified needs as possible. The Corporation maintains records to identify and monitor the amount of charity care it provides. These records include direct and indirect costs for services and supplies furnished under its charity care policy. The total cost of charity care under these policies amounted to $2,970,117 and $3,175,172 for the years ended, respectively. The cost of charity care is estimated by management based upon the cost to gross charges ratio multiplied by the gross uncompensated charges associated with providing care. The Corporation received $691,000 and $616,000 for the years ended, respectively, to offset or subsidize charity care services provided, which is reported as an offset to amounts shown for children and family ministries. 16 (Continued)

19 The following is a summary of the Corporation s support of these programs during the years ended December 31: Medical assistance cost in excess of contractual reimbursement $ 13,707,377 14,912,730 Charity care in support of those in need 3,720,738 3,096,666 Children and Family Ministries supported by DLSM and DLF (charity care): Children s services 492, ,286 Behavioral health 373, ,924 Community services 91, ,978 Total Children and Family Ministries supported by DLSM and DLF 957,450 1,211,188 Scholarships 61,095 68,624 Total $ 18,446,660 19,289,208 (z) Loss from Early Extinguishment of Debt During the year ended December 31, 2016, the Corporation entered into a transaction that involved the issuance of the Cumberland County Municipal Revenue Bonds Series 2016 (Note 5). The proceeds from these bonds were used to fully refund the previously outstanding Series 2014 B Bonds, fund a portion of the costs related to termination of the interest rate swap, fund certain capital expenditures at the DLSM facilities, and to pay for issuance costs. This transaction resulted in the recognition of a loss from early extinguishment of debt in the amount of $420,807 which is recorded on the consolidated statement of operations and changes in net assets for the year ended December 31, (aa) Operating Income The consolidated statements of operations and changes in net assets include an intermediate measure of operations labeled Operating income. Changes that are excluded from this measure include joint venture equity changes, changes in the fair value of swap agreement, and loss from early extinguishment of debt. (bb) Performance Indicator The consolidated statements of operations and changes in net assets include a performance indicator of operations labeled Excess of operating revenues, gains and other support over expenses. Changes in unrestricted net assets that are excluded from this measure include unrealized gains on investments, pension-related changes other than net periodic pension costs, net assets released from restrictions for capital purposes, and a net asset transfer. 17 (Continued)

20 (cc) Use of Estimates The preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (dd) Statutory Reserve Requirement The Pennsylvania Continuing Care Provider Registration and Disclosure Act requires a statutory reserve equivalent to the greater of the total of debt service payments due during the next 12 months on account of any loan or 10% of the projected annual operating expenses of the facilities exclusive of depreciation, computed only on the proportional share of financing or operating expenses that is applicable to residents under entrance fee agreement contracts. This statutory reserve requirement is considered to be fulfilled from equity and fixed income funds included within assets limited as to use. The Pennsylvania statutory reserve as of, was $7,122,163 and $7,205,935, respectively. The State of Maryland regulation requires licensed continuing care retirement communities to maintain an operating reserve equal to fifteen percent of the facility s net operating expenses for the most recent fiscal year. The regulations allow a provider to meet the requirement at a minimum rate of 10% per year as of the date of its first initial certificate of registration up to a total of 100% as of the end of the tenth fiscal year. DLSL-MD was required to maintain a reserve of 9% of net operating expenses, or $1,416,840, as of December 31, 2017, its sixth year of operation, and 7.5% of net operating expenses, or $1,184,213, as of December 31, 2016, its fifth year of operation. The reserves must be maintained in a reasonably liquid form in the judgment of the provider and in accordance with the provider s investment policies. (ee) Change in Accounting Principle On January 1, 2016, the Corporation adopted the provisions of Accounting Standards Update (ASU) , Simplifying the Presentation of Debt Issuance Costs. Prior to the adoption, the Corporation s policy was to present debt issuance costs in other assets on the consolidated balance sheets. These costs are now presented as a direct deduction to the related long-term debt on the consolidated balance sheets. Details regarding amortization of these costs are included under Note 1(l) Deferred Debt Issuance Costs and Other Assets. (ff) Reclassifications Certain prior period amounts have been reclassified to conform with the current period consolidated financial statement presentation. 18 (Continued)

21 (2) Assets Limited as to Use and Investments The composition of assets limited as to use as of December 31 is set forth in the following table: Under bond indentures for debt service reserve fund: Cash and short-term investments $ 971, ,350 Debt Service Sinking Fund: Cash and short-term investments 9,608,211 6,655,083 Under bond indentures for construction projects: Cash and short-term investments 2,640,146 Endowment funds: Cash and short-term investments 685, ,685 Fixed income funds 3,382,796 3,891,608 Equity funds 8,104,338 12,072,569 Donor and other temporarily restricted funds: Cash and short-term investments 834, ,995 Equity funds 6,972,343 6,356,675 Fixed income funds 3,227,757 2,347,110 Assets Limited to Use for HUD Reserves: Cash and short-term investments 2,817,155 4,312,904 By board for designated purposes: Funded depreciation: Cash and short-term investments 235,356 Equity funds 2,195,419 Fixed income funds 1,541,592 Entrance fees and other designated purposes: Cash and short-term investments 365,537 3,663,173 Equity funds 27,551,532 Fixed income funds Statutory minimum liquid reserves: 428,648 19,551,809 Equity funds 4,170,560 4,233,342 Fixed income funds 2,951,603 2,972,593 Total assets limited as to use 44,519, ,856,941 Less assets limited as to use required for current liabilities: Other 9,608,001 9,472,075 Assets limited as to use, less current portion $ 34,911,869 93,384, (Continued)

22 A summary of investments as of December 31 is as follows: Cash and short-term investments $ 5,641,559 3,467,115 Equity funds 72,101,098 32,266,536 Fixed income funds 51,027,627 17,673,815 Alternative investment 4,296,648 4,598,319 Investments $ 133,066,932 58,005,785 The combined composition of assets limited as to use and investments as of December 31 is as follows: Cash and short-term investments $ 20,923, % $ 23,609, % Equity funds 91,348, % 84,676, % Fixed income funds 61,018, % 47,978, % Alternative investment 4,296, % 4,598, % $ 177,586, % $ 160,862, % Total investment return for the years ended December 31 consists of the following: 2017 Temporarily Unrestricted restricted Total Interest and dividends, net of expenses $ 5,291,728 1,463,040 6,754,768 Net realized gains on investments 2,024, ,834 2,726,884 Investment income, net of expenses 7,315,778 2,165,874 9,481,652 Unrealized gain on investments 8,910,261 8,910,261 Changes in unrealized gains on temporarily restricted net assets 2,704,800 2,704,800 Total investment return $ 16,226,039 4,870,674 21,096, (Continued)

23 2016 Temporarily Unrestricted restricted Total Interest and dividends, net of expenses $ 4,405,935 1,230,485 5,636,420 Net realized gains on investments 835, ,550 1,121,597 Investment income, net of expenses 5,240,982 1,517,035 6,758,017 Unrealized gain on investments 1,087,336 1,087,336 Changes in unrealized gains on temporarily restricted net assets 83,071 83,071 Total investment return $ 6,328,318 1,600,106 7,928,424 As described in Note 1(g), a summary of unrestricted investments with fair values below cost as of December 31 is as follows: Less than 12 months 12 months or longer Total Fair Unrealized Fair Unrealized Fair Unrealized December 31, 2017 value losses value losses value losses Description of funds: Fixed income funds $ 34,933,162 1,060,555 34,933,162 1,060,555 Equity funds 114, ,904,690 1,164,887 8,019,090 1,165,312 Total temporarily impaired funds $ 114, ,837,852 2,225,442 42,952,252 2,225,867 Less than 12 months 12 months or longer Total Fair Unrealized Fair Unrealized Fair Unrealized December 31, 2016 value losses value losses value losses Description of funds: Fixed income funds $ 14,794, ,032 14,794, ,032 Equity funds 4,736,921 13,079 19,755,618 2,290,891 24,492,539 2,303,970 Total temporarily impaired funds $ 4,736,921 13,079 34,550,414 2,680,923 39,287,335 2,694,002 The Corporation monitors its investment portfolio and reviews investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. Such evaluations consider, among other things, the magnitude and reasons for a decline, the prospects for the fair value to recover in the near term, and the Corporation s intent and ability to retain the investment for a period of time sufficient to allow for a recovery in value. The declines in fair value as of, are considered temporary. 21 (Continued)

24 (3) Third-Party Reimbursement The Corporation s nursing care facilities and other programs primarily derive their revenues from private-pay, Medicare, and Medicaid patients. Private-pay rates are established on the basis of the cost of delivering services and competitive considerations and, as such, are essentially market driven. In contrast, Medicare and Medicaid payment rates are regulated by the federal and state governments and, as a result, the industry is sensitive to related legislative changes and is affected by reductions in governmental spending for these programs. Additionally, laws and regulations governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates will change by material amounts in the near term. Revenues from Medicare and Medicaid represent approximately 49% and 47% of patient and resident service revenue, net of contractual allowances, for the years ended, respectively. Medicare and Medicaid receivables represent approximately 50% and 47% of patient and resident accounts receivable as of, respectively. Pennsylvania nursing providers are subject to a Nursing Home Assessment (the Assessment) which was approved by the Centers for Medicare and Medicaid Services (CMS) in September The Assessment requires all Pennsylvania nursing homes, except for county homes, to pay a fee to the Department of Human Services (DHS) based upon all non-medicare days. DHS makes supplemental payments back to nursing home facilities based upon a standard rate per Medicaid day claimed. Total nursing home assessment revenues and expenses were $3,868,169 and $2,060,071 for 2017, respectively, and $3,866,533 and $2,029,793 for 2016, respectively. 22 (Continued)